Get an annuity, sail through retirement

Saving up for your silver years is a fairly challenging task. Alongside the saving, it is doubly difficult to choose investment avenues to park your money so that you earn an assured monthly income.

This is where Annuity products come in. These products are designed to provide you with a regular stream of cash after retirement, from the time of your choice, till your death.

Annuities require you to accumulate a corpus with an insurance company by paying premiums. The insurance company then pays you back this ‘deposit' through monthly payments that include a fixed rate of interest.

Investors essentially have two types of annuities to choose from — immediate and deferred. Here we discuss how investors may choose between and buy these annuities.

Deferred annuity products, where you pay a premium today to receive a pension after several years, aren't available from insurers right now due to recent regulatory changes.

Immediate annuity

So, first, let us look at how you can set up an immediate annuity. Such products are offered by LIC, HDFC Life, Bajaj Allianz, Birla Sun Life and Aegon Religare, among others.

To set up an immediate annuity, you pay a large sum as a single premium to one of the above insurance companies and they, in turn, start an annuity payment at a frequency of your choice (monthly, quarterly or annual).

The annuity payments from these insurance companies are based on a specified rate of interest. The current interest rates vary from as low as a simple interest of 4.2-5.5 per cent offered by most private life insurers to a high of around 7.4 per cent in the case of LIC's Jeevan Aksay VI, which is its only pension plan.

Most insurance companies have just one annuity plan without any sub-schemes to choose from.

Rates also vary with age. LIC allows you to start an immediate annuity as early as age 40, while most private insurers allow entry at ages 50-60.

Given that the rates of purchase vary, the monthly pension for a specified sum too varies accordingly.

If you are 50 and if you pay a single premium of Rs 25 lakh, you are likely to receive a monthly pension of Rs 8,500-17,700, depending on the insurer. But if you start an immediate annuity at 60, the payout on a monthly basis would be Rs 11,600-20,300.

The later you purchase an annuity, the higher will be the amount of pension paid. This is because the insurer undertakes to pay an annuity for your remaining years, which would be lower if you are older.

From a tax angle, while the single premium would be eligible for deductions under section 80C, the annuity income would be taxable at your slab rate. A key advantage with a single premium, immediate annuity product is that the entire sum gets invested, without deduction of any charges.

Choosing the right option

Given the options available, and the varying purchase rates, it is obvious that LIC, which has the maximum share in pension premiums, should be your first choice, simply because it pays you the highest return.

Investors can also consider Bajaj Allianz's pension guarantee scheme as it too offers a reasonable rate of pension.

For instance, from the above example, for a Rs 25-lakh premium, the company offers a monthly pension of Rs 15,000. The entry age is 55 in this case.

Savvy investors often use a combination of insurers to set up a pension. They use the pension plans of private insurers during the accumulation phase, but purchase an immediate annuity from LIC at retirement, to get a higher rate of pension.

Important points to note

Annuity options available today from insurance companies have three key options.

One, there are annuities for life at a uniform rate, for defined periods in the range of 5-20 years. If you don't survive for this entire period, your spouse will still receive the pension for the rest of his/her life. Or alternatively, you can opt for pension with return of purchase price or a part of it to your spouse on death.

Three, there is also an option to increase your pension every year by 3-5 per cent.

The choice once made cannot be altered.

If you are 50-60 years old and have a dependent family, we suggest that you choose one of these two - a) assured pension for 20 years, which will cover you until death even if you live longer.

b) pension with payment of full annuity to spouse after your death.

If you take other choices, there may be a potential risk. If you choose pension for life and don't live very long after taking the annuity, the policy would cease and nothing would be payable to your spouse or dependents! The same is the case with increasing annuity rates option.

A final point. Do note that annuity plans give you assured monthly income at low rates of return. They do not budget for inflation during your post retirement life. If inflation remains stubbornly high at, say, 8-10 per cent, then you will need other sources of income to augment your pension.

Therefore, line up such options by way of fixed deposits with banks or debt-oriented mutual fund schemes such as Monthly Income Plans.

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